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The Money System: Introduction to the Author Greco, a former engineer, entrepreneur and professor, is an international authority and adviser on free market approaches to monetary and financial innovation that empowers local economies and makes it more possible to live in a sustainable way and be more resilient to future crises that threaten security and stability.

I was able to understand this book as he explains the functions of money and how money has developed since the founding of the Bank of England. He shows how the control of the creation of money and the institutions that regulate the functions of money, for exchange, for saving and investment and as a measure of value, has increasingly been in the hands of national governments, central banks and private investment banks, a globally networked political elite. This is not only non-democratic and disempowering, making us all dependent on this elite and these dominant institutions, with the money system and the control of money shaped by their world view and the values and interests; but it also undermines the soundness of money and the sustainability of our economy and way of life, economically, socially and environmentally.

Current Money System: its development and problems The three core functions of money are (1) exchange through a payment medium, (2) saving and investment for the future, a way of storing value, and (3) a measure of value. Money as a device for this, and the institutions that support it, can be called the “money system”. Greco shows how instructive it is to understand how money has developed historically as a way into understanding current problems and the need for and the direction of change, the next step perhaps in its development, suggesting another transformational or paradigm shift.

Greco found that the book by Hartley Withers The Meaning of Money (7th edition 1947, clearly a valued work) clarified the transformations that money had gone through in the last 300 years. More recently the historian Niall Ferguson has written TheAscent of Money (08 and Penguin 09), a best selling book (see www.niallferguson.com ). Ferguson brings out the positive functions of banks as well (such as channelling money from savers to those who can use it, fulfilling the investment function of money), whereas Greco, while acknowledging these, focuses more on current problems with the money system that play a major part in the crises and challenges of our age and times.

Greco focuses primarily on the transformations of money as a means of reciprocal exchange and payment, looking particularly at the basis of its value rather than its forms only (coins, paper notes, cheques and so on). Greco sets out the stages identified by Withers: (1) Barter trade (2) Commodity money (3) Symbolic money (4) Credit money (5) Credit clearing.

Money overcomes the limitations of barter (two people each having something the other wants) and enables the need of the buyer to be met when, wherever, and with whoever, the goods or service can be found, any time and any place – and requires sellers also to find what they want elsewhere. A useful commodity that was in general demand could act as payment and the exchange medium. A valuedcommodity could in itself fulfil the 3 functions of money as a payment medium and as a store and measure of value (and gold is still used as a way of storing money in times of inflation or instability in the financial markets). Cattle for instance has served as a payment medium (heads of cattle being the derivation of the word for the concept of “capital” from the Latin for head, c.f capital punishment and city). The word money comes from the Latin “Moneta”, the surname of the God Juno in whose temple Roman coins were “minted”, precious metals in the form of coins, being another valued commodity which was more practical as it was durable, easy to carry around and physically divisible into smaller amounts, with specific standard weights and purity arrived at through a trusted and certified minting process and establishment, a trust that could be abused by the authority issuing it – a king or government, by debasement of the coinage. But the supply of gold and silver is limited.

An early and simple form of symbolic money was the receipt for commodity in a warehouse – a “warehouse receipt” or “claim cheque” – such as a farmer’s receipt for grain delivered which could then be exchanged for goods elsewhere (as used in Ancient Eqypt). Those with these receipts could then exchange or redeem them for grain. Paper notes redeemable by gold or silver coins are another example of symbolic currency. So commodity money and symbolic (claim cheque) money coexisted at this stage.

Credit money, a key step opening up both efficacy and potential abuse, is an IOU, a promise to pay – either in the form of paper money or cheques drawn against demand deposits. Money supply did not have to be limited by the supply of gold or silver. Withers saw this as a key step towards “manufacturing credit” – giving notes not only to those who had deposited metal but to those who came to borrow it, the beginning of modern banking. Withers described this as a mutual indebtedness between the bank and the customer. In return for a mortgage note, his debt to the bank, the customer would receive notes from the bank (the bank’s debt to the customer) which could be exchanged for gold. Money was still seen in terms of coins and banknotes merely as claim cheques. The bank found it could issue notes to a greater amount than the gold or silver in its vaults, while notes were still redeemable on demand. Issuing notes that could be backed up by only a fraction of gold held in reserve (and the rest by collateral) came to be called “fractional reserve banking” (first developed in Stockholm in 1657).

There were now two different kinds of paper money: (1) claim cheques for gold on deposit (symbolic money) and (2) a credit instrument with a promise to pay backed up by some kind of collateral, merchandise or property, against which credit is monetised. But both symbolic money and credit money were redeemable for gold (probably to establish confidence in the new credit money), which led to confusion between them. If there was a drop in confidence in a bank and a rush to claim back the deposits then what was in collateral could not be reclaimed. This becomes a problem when paper money is issued on the basis of unsound collateral. This happened with the subprime mortgage crisis in 2007-8 when banks lent money initially at a low interest rate to low qualified borrowers on the basis of inflated property values and then when the rate was raised many could not pay. Credit money is a great invention if properly issued. The trouble arises when the power of issuing is centralised in a political and financial elite which cannot be controlled when their creation of money is unsound. The proper basis for credit money is not fully understood by most people.

Now virtually all the money in circulation is credit money, as by stages it was no longer redeemable for gold or silver. Banknotes were secured against collateral assets and government obligations or bonds. This credit manifested in the bank’s ledger as a promissory note or mortgage from the borrower ( a loan as a bank asset) and as debt-money in the form of paper notes (the bank’s IOU) or credit in the borrower’s account, a bank liability. In lending money secured by collateral, the bank creates a “deposit” that is credited to the account of the borrower. This is called “monetisation” of the collateral assets, making them “liquid” and spendable – as money. The bank’s assets are its loans (for which it charges interest) and its reserves; and its liabilities are (but not exclusively) the deposits of savers on which it pays interest.

The word “deposit” is confusing as it is anachronism harking back to the time when deposits were in gold and silver, with paper banknotes originally as deposit receipts. But now the balance on an account is called a deposit, that can be in credit. As Quigley states (in Tragedy and Hope, 1966) banks confusingly use the term “deposit” to refer to two quite distinct transactions and kinds of relationship between banks and customers: (1) deposits lodged by savers with the bank, real claims on the bank. They can be used by the bank to lend out – and so be a loan to the bank and a debt by the bank to the customer that can earn interest for that customer and (2) deposits created by the bank”out of nothing” as loans to a customer who paid interest on this debt to the bank. Cheques can be drawn on both kinds of deposit as payments to a 3rd party. Both form part of the money supply, as Greco emphasizes.

By the mid 19th century cheques (an order to pay money rather than money as such, to a specific payee) and checkable deposits (account balances) began to take the place of banknotes as the British government sought to restrict the issuing of banknotes representing credit money by banks other then the Bank of England (Bank Act of 1844). Cheques depend on the credibility of the drawer and the bank as they can of course bounce. The use of cheques and deposits (or account balances) represented the introduction of the clearing process in the banking system. Money was created as account balances, without needing banknotes (the issuing of which was then restricted in the UK). The Amsterdam Exchange Bank had in 1609, nearly 250 years before, enabled merchants to set up accounts denominated in a standardised currency in order to address the problem of multiple currencies in the United Provinces at that time. This pioneered the system of cheques, and then direct debits and transfers. Transactions could occur without being materialised in coins.

The 3rd stage in the transformation of money from commodity money Greco, following Withers, sees as the emergence of credit clearing. Money becomes an abstraction, a score, a way of keeping account, in the give and take of transactions and exchange. The role of retail banks is the vetting of credit requests and the clearing of credit using electronic information and communication systems. Account holders can receive payment of their wages or salaries by electronic transfer and purchase with their debit card or online by computer or smart phone.Your purchases are paid for by your sale of goods, services or labour; “clearing” is offsetting purchases with sales or wages. Notes and coins are used for small purchases only, by some, and cheques now only occasionally. Money here ceases to be a just a “thing” for payments or loans; it is the sum result of a set of relational processes (exchanges) over a day or longer period, as information, a variable number. But banks and society generally still think of money as principally coins and notes, a thing. The fact that the unit of account or the amount of a loan is measured in terms of the amount of currency contributes to the confusion as a note and a unit of value are called the same thing (see W. Zander A Way out of the Monetary Chaos 1936 – available on the reinventing money website). In fact money is both a thing and an account balance based on a relational agreement; Greco uses the analogy of light being seen by physicists as both a particle (thing) and a wave (relational process). In fact the relative difference between accounts payable and receivable over time can be plotted on a graph and the point of difference, above or below the line between the two (above as a positive balance, below as negative, on the vertical dimension), can be joined to look like a wave along the horizontal dimension of time. In 1914 H. Bilgram and L. Levy noted (in The Cause of Business Depressions) that any system of crediting sellers and debiting buyers could be used to perform the function of money as a medium of exchange. But this has not been taken advantage of – whereas now with the advance of electronic information systems this is all the more feasible.

With the current system of the banks offering credit as loans on interest to pay suppliers until it can be paid back by customers, suppliers need to sell more in order to pay back the interest as well as the loan, leaving probably another person or business in the supply chain in debt as there is not enough money in circulation to pay off bank loans. But Greco shows how this chain or network can use credit as self-issued IOUs without the need of a bank as an intermediary, as long as their suppliers accept this. These IOUs can be paid off as the supplier(s) issuing the credit as IOUs themselves get paid. No loans and no interest are involved, and if no notes or coins, then only money as a balance of account. Banks, credit instruments and money as we know it are not needed for the exchange of goods and services carried out this way. The companies do their own credit clearing directly by settling what they buy and sell amongst themselves. It becomes a more organised, and protected, way of selling to customers on credit. Greco calls this mutual credit clearing within a network of suppliers and customers. Traders can be free of the limitations imposed by monopolised bank credit and government money, within a national, and the international, global economy. It promotes local business and more self-reliance around regularly traded goods and services available more locally, and protection and resilience in uncertain times (e.g. food and energy security and risks to the economic and financial system). This needs implementing on the basis of sound financial principles and implementation strategies of course, and needs an established or growing local economic network of suppliers and customers between whom there is trust in relationships and the system they design and create, a network that recognise sthe needs, advantages and practical possibilities, to make it work.

Greco sees the creation of central banks and the collusive relationship between them (together with investment banks) and national governments as key to the main problems with the money system today, alongside unsound loans and/or unsound collateral. In 1694 the Bank of England was founded as a depository for government funds and income from taxes – mainly to enable the king to borrow money for a war. The government could now spend beyond the current income from tax revenue. In return bankers had the privilege of creating credit money – originally as banknotes to pay taxes. The use of credit to create payment out of nothing had been developed earlier. But this took it further. The Bank of England, the central bank, came to have a virtual monopoly in issuing banknotes from 1742, a distinctive form of promissory note that did not bear interest and did not require the parties in the payment both to have current accounts. The currency created by them was later given legal tender status. This gradually became the prototype for central banks around the world, as other countries faced the same pressures and were served by the same international investment banks. President Jackson of the US fought against it as it gave inordinate power to an elite and created more inequality of wealth (the “bank wars” in the US in the 19th century between elitists and egalitarians). This led to free banking for 26 years from 1837 when each bank issued its own currency notes and the evaluation of their soundness was through the market. There were some bank failures with losses to noteholders. Notes were redeemable by gold still, and this could be faster at a distance now with railways and telegraph. When Congress passed the national bank act of 1863 (mainly to pay for the civil war) it allowed free entry into the market of banking and credit, and collateralised bank loans, learning from the free banking experience. In 1913 the Fed was created in the US. As A. Rothbard (History of Money and Banking in the US) states: “the financial elites were responsible for putting through the Federal Reserve System that created and sanctioned a cartel device to enable the nation’s banks to inflate the money supply in a co-ordinated fashion”. President Wilson was aware of this concentration of power, especially in the control of credit. The 2008 presidential candidate, Ron Paul spoke of this power to change the value of the stock market in minutes challenging the principles of freedom and sound money – as the basis of an economy that remains dynamically stable in a self-correcting way. Greenspan, the Fed chair then, said that as soon as money based on a commodity standard (gold or a bundle of basic commodities) is replaced by money that is legal tender by fiat then the producer of the money supply will have inordinate power. This collusive arrangement enables the economic demands of modern centralised power and of defence in the face of threat of war and other forms of attack to be met. Governments will not give this up unless there is some alternative or these needs are not so great.

Prof H. Ritterhausen (History of Central Banks, in German) sets out the evolutionary steps or stages in the development of central banks and their issuing of money:

The exclusive licence to issue notes (paper money) is given to banks by the government as state privilege

The state discovers that the bank is a source of credit for state expenditure that exceeds current tax revenues

Government tax offices accept these still private notes for paying taxes instead of metallic money.

The bank cannot refuse loans to the government in times of emergency.(such as a war).

The issuing of notes becomes excessive so that notes cannot be redeemed for metallic money. Redemption is abolished by law.

The notes are given legal tender power in case they are not accepted or are discounted in the market. Notes are no longer a private bank currency note.

Forced acceptance of the notes and the abolition of note redemption make the metallic standard inoperable; precious metals no longer play a monetary role. The measure of value becomes the paper currency itself. The regulation of note supply by market forces comes to an end. There is no operational measure of value independent of these politically controlled currencies.

C. Quigley writes (in his book Tragedy and Hope,written around 40 year ago but still relevant): “The world’s chief investment (international, merchant) banks –were the agents of the dominant investment banks in their countries……This dominance ..was based on the control over the flows of credit and investment funds in their own countries and throughout the world … through bank loans, the discount rate and the rediscounting of commercial debts…They could dominate governments by their control over current government loans and the play of international exchanges.” Their interests were mainly in (government) bonds (loans) rather than goods, and so in deflation, and in influencing public policy. While exposing the system Quigley supports their goals. Money is politicized; conrolled by an elite.